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FTSE350 Pensions Analysis 2017

Welcome to Hymans Robertson’s ninth annual FTSE350 pension analysis report, which puts the Defined Benefit (DB) pension schemes of the FTSE350 in the context of the businesses that support them.

Occupational DB schemes have had another very high profile year. The resolution of the BHS and British Steel cases has caused the Pensions Regulator (tPR) to review the way it operates. tPR has sharpened its teeth and will now be more proactive and intervene more frequently.

With this in mind, we see two strong themes emerging over the next year for DB pensions:

Pressure to increase deficit contributions. For schemes that are behind plan, tPR expects annual deficit contributions to increase rather than recovery periods to be pushed out further. Schemes that have hedged should be on track, but those that haven’t will likely be behind plan. This focus on deficit contributions is simplistic, and could lead to unintended consequences. It creates an incentive to take more investment risk to increase expected returns, thereby reducing deficits. In our view, the level of investment risk in schemes is absolutely critical. If a lower level of contributions and a longer timescale enables a less risky investment strategy, then in many cases this will increase the likelihood of members’ benefits being paid in full. It will also reduce the strain the scheme places on the employer – a win-win outcome. tPR has signposted that employers should only pay out dividends that are higher than pension deficit contributions if the recovery period is short and the level of investment risk is manageable. Again this is simplistic and could lead to massaging of actuarial assumptions to shorten recovery periods. Risk should be prioritised over cash.

Taking action to reduce costs. The pressure to increase deficit contributions will lead to companies taking more action to reduce costs. 55% of the FTSE350 have already closed their DB schemes to future accrual. The pressure to increase deficit contributions, combined with low yields pushing required contribution rates up to 40-50% of pay, mean there will be more scheme closures. Low yields and freedoms in Defined Contribution (DC) mean that taking a transfer value that can often be 30-40x the annual DB pension is attractive. More companies will therefore facilitate DB to DC transfers over the coming year. Both of these actions make schemes more cashflow negative, and with 75% of schemes already in this position, it is critical to build this feature into investment strategy. Companies need to make sure their cashflow projections and liabilities are regularly updated for actual cashflows. Well run schemes will invest in assets that generate stable levels of inflation linked income.

This report shows that most companies are well able to support their pension schemes, with 85% of companies able to pay off their IAS19 deficit with less than 6 months’ earnings.

I hope you find this report interesting and informative. Please contact me or one of the team if you would like to discuss any aspect of our analysis.